The official "blog of bonanza" for Alfidi Capital. The CEO, Anthony J. Alfidi, publishes periodic commentary on anything and everything related to finance. This blog does NOT give personal financial advice or offer any capital market services. This blog DOES tell the truth about business.

I got an unsolicited email from somebody who wants me to check out Tosca Mining (TSMNF), another penny stock from Vancouver, Canada. This person didn't disclose whether they had a relationship with the company but they urged me to check out some analyst's video. I don't waste time listening to someone else's analysis. My own thinking is like so totally way better.

The incompatibility of hedge fund strategies and ETF strategies is plain. Classic ETFs mimic broad indexes as closely as possible, with a lot of constancy in their holdings and little turnover. Hedge funds can mimic any strategy in the blink of an eye, where holdings turnover rapidly and incur unpredictable tax events. ETFs are cheap because they seldom change their makeup. Hedge funds are expensive because they change what they hold a million times a day. Changes in ETF holdings lag changes in their representative indexes by no more than a day or two. Changes in hedge fund ETFs, according to the filing documents themselves, can lag the representative hedge strategy's 13F filing by as much as 45 days. That giant lag alone makes a copycat strategy meaningless.

Investors who think that buying a hedge fund will give them outsize returns need to subtract the two-and-twenty premium to calculate the impossibly large long-term alpha the fund will have to generate just to beat the tiny long-term beta of an ETF. Investors who buy a hedge fund ETF will get the worst of all possible worlds.

Better PR isn't going to mollify an investing public that no longer believes the equity markets are fair to investors. Wall Street has pushed its advantage in asymmetric information so far that the people on the other side of its trades don't want to play anymore. No one is going to believe a news release stating "Wall Street wants to try harder" after an avalanche of stories on how Wall Street has picked investors' pockets. No investor is going to trust Wall Street until senior executives who commit fraud - especially those at MF Global - are prosecuted.

I can't recap the entire two-day knowledge fest but I'll offer some highlights. Sen. Lisa Murkowski (R-AK) gave an impressive talk on Congress' efforts to streamline permitting regulations for mining and the need for more aerial hyperspectral imaging surveys of unexplored properties in the U.S. David Sandalow, an Assistant Secretary at the U.S. DOE, acknowledged that the White House Office of Science and Technology Policy was the natural choice to lead the "whole of government" interagency effort on critical metal supply security. DOE's Innovation Hubs are fully funded, but IMHO they should focus on business incubation and license out the tech they're developing. One panelist said something ignorant about wind energy, that its cost is essentially free once you amortize away the initial capital costs (IMHO this is stupid because it ignores the cost of regular maintenance, inspections, blade failure, etc.).

The panel on automotive tech and grid storage made it clear that there will be no shortage of lithium to meet the world's needs, which is one reason why the Li-Ion battery market is expected to consolidate into a smaller number of manufacturers. The automotive panel also emphasized that the U.S. will need to update its transmission grid to accommodate a growing hybrid/electric vehicle market, and the demands of energy storage at grid level will help drive smart grid build-outs that will optimize charging times for vehicles. The graphite panel noted the many applications for this material but some have no synthetic alternative. Ambassador Ichiro Fujisaki of Japan discussed how Japan, the EU, and the U.S. have coordinated their WTO complaint about China's REE policy; they've learned lessons from past oil supply shocks and know that Japan's increasing reliance on renewable energy (especially after the Fukushima meltdown) will make REEs critical.

The final speaker, Dr. Si Jinsong from the Chinese Embassy, restated the PRC's official view on why they are curtailing rare earth exports. Environmental damage is IMHO a red herring. China can always dial back its domestic industrial use of REEs or get more aggressive about enforcing environmental regulations to mitigate damage from REE production. His claims that China has exported too much already and is facing resource exhaustion mean little to me. REEs are typically found in conjunction with base metals and China still has plenty of those. The real money quote came late in his presentation when he said the U.S. and China should work together to expand high-value manufacturing. That is as transparent a statement of intent as the West will ever see from China. The PRC's longstanding policy is to attract the onshoring of high-tech manufacturing supported by foreign direct investment so Chinese engineers can capture technical knowledge and Chinese industry can build a high-tech export base. U.S. policymakers need a thorough education in China's grand strategy, and they should start by reading Unrestricted Warfare to see recommendations straight from the People's Liberation Army.

I led off with my assessment of the massive imbalance in the critical metal market and forecast for a future balanced market. Any market where 97% of supply and 100% of alloy processing must originate in China is the definition of a market far out of balance. I argue that a balanced market in strategic metals will eventually look like today's energy market. A power plant doesn't care if the feedstock is natural gas or coal because you don't have to change a turbine's physical structure to use either one. A transmission grid doesn't care whether electrons come from hydropower, geothermal, solar, nuclear, or fossil fuels so long as those electrons can get to your home appliances. Eventually the metals markets will balance when diverse supply sources, efficient technologies, and synthetic substitutes can arbitrage away single sources of supply. U.S. GDP has grown for the past several decades even though per capita energy use has declined. We can use the same energy metrics for the metals market.

I noted thatMolycorp'sacquisition of Neo Materials changed the game for REE producers by creating a true vertical business model. The deal was cash-heavy rather than stock-heavy, which I thought odd given the strength ofMCP sharestrading at 23 times earnings. I wondered out loud whether Molycorp thought that the balance sheet risk of assuming a half billion dollars in debt outweighed the avoidance of shareholder dilution. Molycorp is the only REE producer than has the financial and operational strength to initiate M&A; all other REE producers are still young and are thus more likely to be bought themselves (like by an oil supermajor seeking lanthanum or cerium for fluid cracking) than to be buyers of alloy processors.

I threw several policy prescriptions at the audience, starting with a big one for federal government policy. Several other panelists had noted that DOD seemed to be the weak link in the interagency effort to secure critical metal supplies. I think I know why. DOD's weapon system procurement program managers are selected from career warfighting officers, which makes sense if you want people who can dream up future capabilities for armored vehicles and fighter aircraft. The weakness of this approach is that warfighters don't think like logisticians. They don't know how to reach down three or four levels worth of subcontractors to find supply chain vulnerabilities. I would like to see DOD'sDefense Acquisition Universityincorporate supply chain security into its curriculum so program managers get the insight they need. I would also like those professional logisticians who do join the acquisition workforce to think more like intelligence officers when they screen contract sources for components and raw materials. The intelligence community has plenty of data on natural resource repositories in many countries; developing indicators and warnings of supply curtailments that procurement managers and logisticians can use should be a priority for the intelligence community.

I also had three other policy recommendations up my sleeve; these were more attuned to things that will help the markets for critical metals become more transparent and liquid. First, I argued that some exchange (preferably theChicago Mercantile Exchange) should create a futures market for rare earth metals. Producers and end users of both base metals and precious metals can hedge their needs with future contracts in gold, copper, and steel. Agribusiness can do the same with contracts in rice and soybeans. Creating contracts for rare earth metals seems like a decent thing to do for manufacturers who can't mitigate single-source supply risk with contracts for guaranteed delivery from miners. Second, I believe theU.S. Securities and Exchange Commissionshould adopt some version ofCanada's National Instrument 43-101 resource reporting conventionthat accommodates nuances in ore deposit volumes and grade quality. This will accelerate mining investment in the U.S. by allowing miners to identify more exploration projects that show some early promise. Finally, I suggested that the U.S. government fund an estimate of the production cost curves for REE mining projects worldwide. Investment banks publish costs curves for base metals, precious metals, and oil/gas wells because the thousands of those sources worldwide are well-known. The small number of rare earth mines operating worldwide are so early in production that their costs are only estimates, or they are in semi-transparent economies like China where state subsidies can mask true cash costs. The U.S. intelligence community has enough analytic horsepower and data to publish initial estimates of the world's REE mining costs. Uncle Sam should do this in the spirit of theCIA's World Factbookas an open-source, unclassified academic reference for the entire world, and the best place to publish it is on theU.S. Geological Surveywebsite.

That just about completes the wonderful time I had at TREM12. I made plenty of contacts from theDefense Logistics Agency, the Institute for Defense Analyses, and other government agencies that will have to carry the ball on policy execution for critical metal security. I even got some free entertainment when I saw a junior executive from a mining company try to flirt with a hot babe from an executive branch office. I'll conclude by saying that I'll definitely return in the future, because I can never get enough lunch buffets, fruit smoothies, and house recipe cannolis from theRitz-Carlton Pentagon City. It's nice that TREM holds its annual conference someplace swanky.

The local tech community held a milestone event today. TechCentralSF and Craig Newmark invited local military veterans to take part in the first ever San Francisco Startup Veteran's Weekend / Hackathon. It's telling that TechCentralSF had to specify that this was intended for military veterans, because professional techies and entrepreneurs often refer to themselves as "startup veterans" with no reference to the original meaning of "veteran."

I absolutely had to take part in this event. I even pitched an idea on the first day but I couldn't convince a critical mass of programmers to get excited about coding it. I'm going to keep it close to the vest until I've refined it some more. I did spend some time talking to other teams about their ideas. The one team I really liked was launching The Peace Academy. Their concept is to run an art auction both physically and online but enable it with a quantum tunneling processor that directly channels human consciousness. This concept is pretty far out and it will take a while for most people to catch on. Stay tuned for more details as I get a better understanding of how they plan to execute.

These kinds of events should be a regular part of the local tech scene. Separating military veterans have plenty of skill but little opportunity to use it because of a wide gulf between the veterans community and the business community. Veterans are easily trainable and work long hours with little regard for personal reward. Those traits make them ideal employees for tech startups. Word of veterans' abilities will soon spread with a few more hackathons.

I was slightly disappointed that Hermione Way did not appear as scheduled. She is a babe and you can see for yourself by searching for her online. I was hoping she would appear garbed in her famous microphone outfit (you'll see what I mean) but it was not meant to be. Maybe she'll show up at the next veteran's hackathon. That's reason enough for me to return.

I first took note of the Jumpstart Our Businesses Act, a.k.a. the JOBS Act, in one of John Robb's posts. It seemed like a cute idea but I was skeptical that such a liberalizing reinvention of the capital markets would make it into law. The U.S. financial system is so skewed towards large institutions that something so amenable to small capital raises would have to swim against the tide. I thought it was some lawmaker's hobby horse or a gesture to the venture capital sector. I fully expected that it would either die before reaching a floor vote or emerge unrecognizable as TBTF-friendly filler.

I took further note of the bill when I read a scathing criticism in the Huffington Post signed by William Black and Janet Tavakoli, two names among many whom I respect for their analysis of the financial crisis. They are alarmed at the possibility that the JOBS Act may engender further criminality and ensure continuing economic crises. As much as I respect their concern over financial market health and investor protection, I believe their objections to the JOBS Act are based on incorrect premises.

Bill Black correctly identified deregulation as a major contributor to the savings and loan crisis of the 1980s. His objection to the JOBS Act rests on a similar premise: Lack of regulatory supervision of small institutions will embolden them to make irresponsible decisions with other people's money, and the consequences of those decisions will then be borne by taxpayers. My response is that the 2008 financial crisis was engendered by several actions that had little to do with securities registration for undercapitalized small businesses. The repeal of the Glass-Steagall Act created an environment where financial supermarkets could make equity and derivative bets backstopped by taxpayer-guaranteed savings accounts. A policy bias toward homeownership spanning several administrations incentivized government-sponsored mortgage poolers (specifically Fannie Mae and Freddie Mac) to securitize things that should never have been securitized. The Federal Reserve's loose monetary policy under Alan Greenspan kept the cost of capital so low that mortgage creation seemed to be a no-risk road to profit. All of these things led to multiple asset bubbles that popped. None of these things had anything to do with the needs of small enterprises for capital.

The JOBS Act makes minor changes to regulation that will allow ordinary non-millionaire investors to take equity in privately-held companies. The critics' concern that this approach will engender fraud is misplaced. Existing securities rules require public companies to file regular financial statements with the SEC. The statements for thousands of penny stocks are available at the click of a button and yet too many investors buy the stocks anyway, thinking they're getting bargains. Check out the dozens of blog articles I've written in the past few months on useless stocks whose SEC statements routinely cast doubts on their legitimacy. People invest in them anyway. Enron, Worldcom, Tyco, AIG, Lehman Brothers, and now MF Global were all well-known companies that plenty of smart institutional investors thought were great investments. They failed anyway. Regulation and disclosure help people who spend time doing homework. They can't cure human stupidity.

The JOBS Act will not eviscerate an American financial regulatory regime whose main deficiency is lack of enforcement for existing rules. It will energize small businesses by granting them access to a capital pool beyond accredited investors. It may even remove the "hair on the deal" excuse some VCs use as a reason not to back a startup. If plenty of ordinary people can invest in plenty of startups, hairs on deals have a lot less stigma.

I spent this weekend at a startup hackathon in San Francisco where multiple teams of technology experts created business solutions. They are all long on talent and enthusiasm but short on capital. The JOBS Act will give them the extra juice they need to win. I support its enactment into law.

The unwanted solicitations to invest in penny stocks don't just come via junk mailers. They also arrive via junk email. Today I got an email from Ultimate Penny Stocks, which is really owned by something called Promo Kombo Ltd in the British Virgin Islands. Go figure. The email touted Empire Post Media (EMPM), a penny stock that purportedly does post-production work for the movie and TV industry.

The reason for taking such a company public escapes me. Post-production companies are typically small private companies that have little need for access to the capital markets. There is no realistic expectation for such a company to expect to grow to a size that would justify making it a publicly-traded stock.

The company's 10-K from Mar. 14, 2012 tells us plenty. The proceeds from the company's IPO all went to the founder and not to the company. They netted a whopping $15,050 in capital just to get listed. The founder later made a cash infusion for $14,192 back into the company. Even he couldn't make any money off this one. Like I said above, the business model for something like this doesn't justify capital market access. Their burn rate and need for additional capital raise substantial doubt about their ability to continue as a going concern. It is ridiculous for the company to have over 250M outstanding shares.

I have only seen penny stocks lose money with two-dimensional approaches but Empire Post Media manages to lose money in 3D. You don't even need special glasses to watch the show. If they want to keep developing reality-based entertainment, maybe they can start by documenting their own difficulties making money.

Another brand name brokerage may be headed for complete absorption by a long-time rival, in this case Smith Barney. Morgan Stanley is reportedly hungry to devour the chunk of Smith Barney it doesn't already own. That would be the final unraveling of the house that Citi built during the late 1990s in its bid to become the first true global financial supermarket. Its acquisitions of Smith Barney and the Travelers insurance group proved to be so unwise that it has unwound much of what it bought since then just to raise enough capital to survive.

I recall doing a case study of Citi in 2002 for my MBA class in M+A. I was the lone voice in the class arguing that Citi's mergers would prove to be a strategic disaster and I was able to sway my teammates to agree with me. Another team gave a competing presentation arguing Citi's mergers would work out great, relying exclusively on DCF projections and other quantitative estimates without any qualitative assessments of strategic fit. Ah, memories. It goes to show that academic rote only gets you so far. Truly insightful analysis often requires an intuitive leap.

Citigroup would be wise to sell its stake now before the renewed recession hits retail investors' portfolios and Smith Barney's revenue. Oh, BTW, none of these firms ever seriously wanted to hire me so I wouldn't be terribly bothered if they all suffer.

Inter-Citic Minerals (ICMTF / ICI.TO) first got my attention at the San Francisco Hard Assets Conference a few years ago as a unique Chinese gold exploration play open directly to U.S. investors. China at the time had just emerged as the world's leading gold producer and had launched its strategy of building its national gold horde. I began watching Inter-Citic in earnest to see if it would break out.

Their 2011 Annual Information Form mentions completed 43-101 results but their exploration program has not matured to the point where they can determine 2P reserves. The ore grades look decent but production is still years away and the mine awaits permitting. The Q4 2011 financial statements indicate that they probably have enough cash and short term investments (over $11M in Nov. 2011) to survive another year of $6M+ losses without a capital raise. Given the increasing problem of inflation in China, miners like Inter-Citic should factor in larger capex expenditures for future budgets and should accelerate the dates of whatever future capital raises they may have planned.

What's notable from the Q4 financial statements is Inter-Citic's enormous capital deficit (i.e., the equivalent of negative retained earnings) of over $53M. Inter-Citic's own published estimates put the NPV of this mine between $198M (with gold price at $750/oz) and $457M (with gold price at $1050/oz). The Dachang mine needs to operate for at least one to two years of its projected nine year life just to to dig the company out of that hole, let alone create real value. If they get their permits by 2013, this means the company won't create real shareholder equity before 2014 at the earliest. Here's hoping they keep their estimated cash operating costs below $404/oz indefinitely (which IMHO is actually a pretty competitive number).

I'll keep watching Inter-Citic for strategic reasons. China still wants to build a domestic hard asset horde to gradually supplant its U.S. Treasury holdings in a way that doesn't provoke a run on the U.S. dollar. Encouraging the development of mines like Dachang, even if foreign-operated, is a natural part of that strategy. The PRC will likely continue to buy gold from domestic production and sequester it from the world market, so Inter-Citic will face a very generous customer with deep pockets if it ever gets its permitting completed. The company's well-connected Chinese strategic investors (including the Zijin Mining Group) may come in handy.

Eastmain Resources (EANRF / ER.TO) is another low-priced gold miner, with the stock barely moving past a dollar for many years. I started looking at this company to figure out why their stock is at such a low price. I then began to wonder why they've been in the gold exploration business for so long.

You'd think that after two decades of existence they could have had some real success by now and broken out of the bush leagues. They have plenty of unofficial and inferred resource data. The Clearwater projects are the company's flagship missions. Its other efforts are ancillary at best and may be of interest as spinoff properties.

Their Eastmain mine site is their other truly prominent property. Its main value at the moment is as a leased base camp for a developer contracted by the Quebec government to build infrastructure for Plan Nord. The smart thing for Eastmain to do would be to use this lease revenue to fund a final assessment of its most desirable projects. Too many discovery-focused gold companies just use whatever cash they raise to finance more acquisitions of properties that have little ultimate hope of production.

Goldcorp owns over 7% of Eastmain and is their largest shareholder. Both Clearwater and Eastmain have excellent mine-ready infrastructure, so there is no physical reason why the company can't explore a JV with Goldcorp or some other big producer to start serious work on developing those two areas as working mines. The problem IMHO seems to be inertia. The company has been a prospector for so long that it may not realize the time is right to shift to development. All of the mining types in the management team have strong prospecting backgrounds, so changing the corporate orientation to JV development may require a push from outside. Goldcorp, give these folks a call and tell them you're ready when they are.

I get annoyed when a news headline doesn't reflect the content of an article. Here's one on the Permian Basin's supposed value of $2T. At first glance I thought the title was alluding to some projected future value of production from some brand-new source in the basin, which is why I clicked on it in the first place. Reading the whole article leads to a different kind of discovery.

The article specifies that historical volume of the basin's oil deposits would be worth $2T at current market prices of over $100/bbl. That's a neat trick, projecting today's prices backwards in time onto oil that was originally pumped in the 1920s. The article admits that the basin's proven reserves are currently 4.5B bbls. Multiply that figure by the WTI price of $105.68 for March 20, 2012 (the most recent one available from EIA) and we have a total present value of $475.56B for the basin's proven reserves. Hey, that's a lot less than $2T; in fact it's only 23.78% of the big number. Do the same math comparing the 20B bbls already pumped to the 4.5B remaining. It pays to understand that when oil producers talk about a basin that's over 76% depleted, the easily reached oil was pumped decades ago. The remaining stuff will cost more to extract, and the cost of production hasn't even been figured into the simple math in the article.

I get even more annoyed when reputable sites like PennEnergy pass on articles like this that originated as PR pieces. The originator, RainChief Energy (RCFEF), is a penny stock that hasn't made a profit. It was formerly known as "Black Diamond Brands Corporation" doing who knows what. The math for this company is even simpler than my math above, with only one non-producing well on their property. There's plenty of oil left in the Permian but right now RCFEF isn't pumping any of it.

Full disclosure: No position in RCFEF or other companies mentioned in the puff-piece.

I first became aware of OncoSec Medical (ONCO) about a year ago when it was struggling to make an indentation (a pun on its tech) in the medical device market. I noticed this month that it's now being touted in a free mail teaser from Trinity Investment Research. Feel free to peruse my many posts mentioning that outfit and how it touts low-priced stocks that later go nowhere. You should know that shops like Trinity make their money from companies that pay for publicity. The first page of Trinity's pump letter shouts that this $0.75 stock deserves a $59 buyout bid. Let's look at facts to see if that wish holds up.

I've learned one very important thing from being an early stage investor in a medical device company (not OncoSec) that is succeeding in business. The CEO of a medical device company must be an executive who has deep experience in the sector, preferably in product development and marketing. Serial entrepreneurship really helps. The CEO of OncoSec is someone who has been a law clerk and intern analyst. His previous responsibilities have been in harmonizing merged companies rather than building companies from the ground up. His most recent leadership experience was with Inovio Pharmaceuticals (INO), a penny stock that has lost money for years. It's notable that OncoSec's chairman was a VP at the venture capital firm where OncoSec's CEO had been an intern. The chairman seems to have brought him over from Inovio in March 2011, where the OncoSec chairman is also Inovio's chairman. Are these two guys related? Anyway, the chief business officer and director of clinical operations have relevant experience.

The company is still losing money but that's to be expected for something still in its developmental stage. I just don't see how anyone can claim OncoSec deserves a $59/share buyout while it has no revenue and still awaits IP protection for a commonly used technology.

Full disclosure: No position in ONCO (or other companies mentioned) at this time.

Wednesday, March 21, 2012

I'm surprised that Greece paid a really tiny fee to its bond swap advisors. I'd like to know how they got away with such a tiny payout given the protracted length of the negotiations, epic deal size, and complexity of the offer. There's more to this than meets the eye. I wonder whether Lazard Freres stands to make anything on CDS payouts if the swap unravels. Greek elections will put that to the test.

The prospect of hyperinflation demands due consideration of hard asset alternatives in a portfolio. I've been exploring master limited partnerships (MLPs) to see if they fit my investing style.

I spend my daylight hours hearing roadshow pitches from oil and gas prospectors who explore producing wells one property at a time. These wells are difficult enough for a small company with limited finances. Pooling single wells into MLPs aggregates their production and enables partners to allocate capital where it can add the most to production. Pipeline MLPs are intriguing for a related reason. Their cash flow is the result of amalgamated production in large regions, regardless of how poorly a single well may be performing at any time.

Applying some Boglehead theory to MLPs leads to the conclusion that MLPs arbitrage away risks specific to single wells and pipelines. It follows that an ETF of MLPs would arbitrage away risks of local geography and single MLP structures, leaving an investor with broad exposure to a flow of hard assets.

I will posit that the cash flow generated by an MLP ETF is a rough substitute for the cash flow generated by fixed income investments. One crucial difference can make all the difference in a hyperinflationary environment. Inflation gradually destroys the principal value of a fixed income security and reduces the real value of its coupon payments. Even TIPS may not be immune to this destruction if their principal resets are not frequent enough to keep pace with inflation, or if the resets are based on artificially suppressed CPI calculations. A hard asset ETF such as an MLP ETF may not suffer such a deficiency. Its cash flows are derived from the nominal value of payments made for resource flows, so its value should theoretically hold during hyperinflation if it is rapidly marked to market.

The only MLP ETF I am currently considering for this role in my portfolio is the Alerian MLP ETF (AMLP). I have not purchased it yet for several reasons. First, it trades at a multiple of 22 times earnings, pretty pricey given the economy's long term average P/E of 14. Second, its expense ratio is frighteningly high at 0.85%. Finally, it has only been around for two years, and has not paid enough coupons for me to find its value using something like my REIT ETF valuation methodology. I believe that methodology is applicable to an MLP ETF because REITs must pass through their cash flows as dividends to shareholders, just like MLPs.

I like that AMLP is optionable, so that if I did own it I could write short puts under it while inflation drives it up. Other MLP substitutes like ETNs don't have that flexibility. Come to think of it, I may decide to buy into it despite my reservations above if inflation really does get going. Bargain or not, hard assets that generate cash flows bring the best of many worlds when hyperinflation starts destroying the value of everything else.

Full disclosure: No position in AMLP at this time; this disposition could change with the onset of high inflation in the U.S.

I could understand starting out with a token amount, say $0.01/share just to establish a dividend policy and leave room for future growth. The danger in announcing such a large-scale payout is that, in any future downturn, Apple will be forced to consider cutting its hefty dividend to conserve cash. Wall Street almost always interprets dividend cuts negatively.

Tech companies are not "widows and orphans" types of stocks because their monopolies are by definition based on technologies subject to rapid change. Most true monopolies (like utilities and some Class I railroads) are geographic monopolies and are thus able to extract true monopolistic rents because their customers can't just pick up and move if they don't like rate increases. Technology companies can't extract the same kinds of rents because there's always the threat of other upstart technologies just around every corner. Monopolistic rents contribute to stable dividends more than anything else in a business model. Just ask Warren Buffett.

Apple could have used its massive cash pile to embark on a truly monopolistic development. It could have leveraged both its brand reputation for user friendliness and its knack for building robust platforms into a user interface for in-home smart-grid technology. One growing roadblock to smart-grid adoption is the concern that Big Brother, whoever he is, could sweep up data on household electricity use into something nefarious. The retail consumer's interaction with this "last inch" interface will determine its ultimate penetration. An Apple interface on in-home smart grid meters could do wonders for enabling local energy conservation and for alleviating common fears about scary new technology. It could also tie Apple permanently to to the monopolistic models of energy utilities, securing its dividend forever.

Hey folks, here comes my portfolio update following an options expiration weekend. My covered calls all expired unexercised, so I renewed the call positions I typically have over GDX and FXI. The value of GDX has fallen so far from its high that I'm willing to risk adding a little more involuntarily, so I wrote some puts under GDX with an expiration date next month. I have the cash to buy shares if the strike price is triggered. Picking up a little extra gold in the ground may prove useful as the U.S. edges closer to a hyperinflationary environment.

Speaking of hyperinflation, I remain on the lookout for equity positions in hard assets or sectors that serve hard asset production and distribution. This can cover a broad gamut of things including energy production, energy distribution, railroads, pipeline operators, oil and gas MLPs, mining, and certain types of real estate. This approach only seems broad when you consider that it excludes wide swaths of the larger economy that will probably not perform as well during hyperinflation. I plan to stay as far away from consumer retailers, residential real estate, and consumer technology as I can for the next few years.

I still have my small holdings of California municipal bonds and I count off the days until they mature. The return of my principal will give me the opportunity to see if an allocation to the TIP ETF will maintain a fixed income position that can adjust to hyperinflation.

The rest of my liquid portfolio is in cash. I await the European trigger for a broad market correction. I do not believe I am waiting in vain.

Last month I went down to the Cloud Connect 2012 conference in Santa Clara. If you're wondering why it took me a month to write up a synopsis, it's because cloud computing is pretty far afield from the business topics I usually cover on this blog. I had to take the time to understand just what all this cloud stuff is about. I'm not some tech-addicted early adopter; I prefer to see how new developments shake out before I think about jumping in.

I'm all about keynote speakers, and there were plenty of them on the platform. Steve Wylie, Cloud Connect's general manager, set the stage for us. Hey, what happened to the gal who promotes other UBM events? She must be busy. Anyway, Steve briefly mentioned that cloud's main effort has shifted from defining its existence to building a practice. I guess we can look forward to more intermittently employed IT professionals calling themselves cloud consultants.

First up was Alistair Croll, currently with Bitcurrent. He described the evolution of measurement from feet to horsepower and later conventions to argue that computing power as a unit of measurement is becoming obsolete. IT professionals must add value with virtualizations because infrastructure is moving to IaaS: Infrastructure as a Service. That was the first of several terms I learned at this conference, all of which seem hard to define because they bleed into each other. Like, where does IaaS end and PaaS (Platform as a Service) begin? Hire a cloud consultant and they'll explain it all to you.

Lew Tucker from Cisco told us that clouds come in public, private, and hybrid flavors. The cloud model that an IT practitioner prescribes for a client has to fit. I saw some similarities in Lew's design perspective with what Alistair presented. I grabbed Lew's thoughts as fast as I could: IT pros build apps on several layers of abstraction; open source development helps build clouds; having a "network service" provides linkages as a translation layer between complex physical infrastructure and user experience; controlling host names and IP addresses is the key when creating virtual isolated networks in a multi-tenant environment.

Bill Gillis from Beth Israel Deaconess Medical Center said that losing paper charts would be a critical problem in patient care, so building system access was a key thing. Building a private cloud maintained the center's control over patient information (aha, IT pros, your private clouds are attractive for a sector very focused on the confidentiality of sensitive information). Government stimulus money has pushed private practice physicians to migrate patient records to the cloud. Hmmm, I wonder if that's a Medicare mandate now. Anyway, Bill also said that many hosted apps have known security flaws, so virtual patching can apply fixes. If you really must know, virtual patching establishes rules for a firewall that don't alter the underlying code.

Jan Jackman from IBM was up next. BTW, IBM is all over the cloud space and I suspect their hidden agenda in sending representatives to cloud events is to find technology they may want to acquire. That's what I'd do if I were them but I have no way of knowing whether they consider any of the vendors here to be acquisition targets or potential JV partners. Anyway, Jan said there's no one way to view monetization. Content providers can pay for only those parts of the cloud service they actually use. IBM uses an open source ecosystem of many partners. Multiple ecosystem partners participate in every step of the cloud development lifecycle model. I wonder whether adding too many partners inhibits topline revenue growth for a cloud value chain. I mean, at some point your number of partners becomes unmanageable and monetizing them all may not be worth the effort if they don't all deliver.

Geva Perry, author of Thinking Out Cloud, said CIO magazine surveys from 2009-2011 showed a gradual adoption of cloud computing. Organizational "creep-up" showed that adoption started at the bottom with developers. The phrase "CIO is the last to know" shows how top IT executives don't drive cloud adoption. IMHO the irony there is that CIOs are the ones who ultimately determine capital spending budgets, so the legacy architectures they approved must have had sufficient bandwidth and internal flexibility to enable the proliferation of a cloud ecosystem. Anyway, Geva mentioned the federal government's own apps store, which I didn't know existed. Geva said vendors should design and build products that enable viral adoption by the rank and file people in an enterprise. IMHO, the lesson for corporate honchos is that small, nimble cloud apps will move faster than a big IT project that has to go all the way up to the CIO for approval.

Jesse Robbins from Opscode was my favorite speaker at the entire conference. The brilliant hits just kept on coming from this dude. I'm going to restate his best points without interpretation. He said every company learns that complexity increases with scale and that latency can cause many failures. Designing for failure allows resilience. Large-scale fault injection across multiple systems is called "resilience engineering," putting people first. IT pros should expect system failures and plan periodic scenarios that anticipate failures. Physical safety standards and building codes are products of what structural engineers have learned about building failures. Applying this to IT means living through failures can help design improvements. Cloud pros shouldn't rely on one-time load balancing; instead they should build incident management tools around routine daily processes. "Infrastructure as code" gives you many knobs and levers to control systems. Mean time to recovery (MTTR) is a better metric than mean time between failure (MTBF).

Alistair Croll made a repeat appearance. He said that up to now content creators have made their money from scarcity but consumers want content immediately. Merging content with software and devices is messy for providers but consumers like to copy and tweak. I had to reflect on this from my perspective as an amateur user of web content. IMHO the demand side will eventually win unless bad laws (SOPA!) interfere with the market's natural evolution. I'll never forget a mantra I heard in the 1990s during the Internet's early days: "Information wants to be free." Just as I was beginning to digest this stuff, Alistair threw out a curve ball by mentioning the Thingiverse. OMG, it's a whole mess of open source designs for 3D objects! That is exactly the kind of resource a System D entrepreneur could use in desktop manufacturing! Anyway, I'm pretty sure Alistair mentioned it as an example of an open source approach to growing cloud architectures. Alistair finished by saying that stepping away from "root" ability to hack/open/meddle in content will be an attack on general purpose computing and toward monopoly. Users and developers should fight for the freedom of computing.

I missed a couple of early Wednesday speakers but the panel was cool. The panel's consensus was that open source architecture is the way forward. Architectures face a choice between open/complex versus closed/simple, so don't get trapped in one that's not adaptable. Service providers with closed models will eventually see the benefits of breaking down firewalls to allow outside apps.

Zorawar "Biri" Singh from HP said "hybrid delivery" spans three areas: non-premise private cloud; managed cloud (i.e., a delivered service for a customer's specific need); and public cloud. I suspect this taxonomy is HP's way of branding its service offerings across the cloud spectrum. Anyway, Biri gave us a pretty good definition of "open stack" as information layered upon apps that are in turn layered upon infrastructure. That's as good enough of a rule for me as I try to sort through SaaS, PaaS, and IaaS.

The final keynoter I cared to hear was Robert Holleyman from the Business Software Alliance. He thinks Japan has the best regulatory model and that Europe is an excellent export market for U.S. cloud providers. IMHO we won't be exporting much cloud stuff if we have to rely on Indian and Chinese IT pros who are increasingly returning to their home countries after their education and initial training here. Anyway, Robert thinks that Brazil and China will be large, growing cloud markets but may not be open to the U.S. That makes sense; why should they be open to us if they have grown their own IT talent for a generation? Robert emphasized three things the U.S. needs to compete effectively: consistent privacy policies; government buying power used constructively on the best technologies; and prevention of cybercrime and IT theft. I say good luck getting any of those from government agencies that will soon be starved for funding. If the cloud industry wants coherent policy and funding from Washington, they need to lobby for it and find those lawmakers who truly "get it" outside of Silicon Valley.

These keynotes filled up the mornings so I had to find something to do in the afternoon for the two days I had a free expo floor pass. The booth people were cool but frankly their explanations of what their respective companies do went over my head. Microsoft had one of the coolest booth configurations. Some other purveyor of cloudiness brought in a 1950s-style aluminum camping trailer. I learned a few of the basics of this emerging subset of computing but I'll leave the heavy lifting to the hard-core IT community. I did score some free T-shirts from a few vendors. I was also grateful that a few vendors staffed their booths with some attractive women. That's reason enough for me to return to Cloud Connect next year.

Yeah, Fed dude says there's little risk of inflation spiking past 2%. He needs to read today's BLS news release, showing the CPI-U for the past 12 months has already grown 2.9%. Federal Reserve officials know pretty dog-gone well what the real numbers are and how their ZIRP policy makes them worse. They can't let up because, like any political actors, they desire reappointment and want to stay in the limelight. Being publicly visible and keeping the perks of power are no doubt addictive. It's hard to walk away from positions that keep one's name in the headlines unless Goldman Sachs makes a far better offer than Uncle Sam.

There is no recovery in the U.S. The Fed knows this but won't admit it; to admit error now would invite scrutiny, blame, opprobrium, and loss of power. Dysfunctional policy thus continues until such time as a bond market revolt makes real interest rates too ugly to ignore.

The Fed thinks most U.S. banks are in good shape. Yeah, right. Defining "good" as "good enough to be made whole by another taxpayer bailout and emergency Fed swap line" is the only way that assessment makes sense. Citigroup's failure of its stress test only means it will be first in line for the next bailout.

Fitch upgraded Greece's debt rating after its bond swap. This one makes even less sense than the first two articles. The swap increased Greece's overall sovereign debt by 30% and the deal's required austerity measures will depress economic growth, hurt tax revenue and make debt repayment even more difficult.

Reading these three news stories in sequence shows a progressive decline in critical thinking skills when comparing European finance ministers to Fed analysts to credit rating analysts. No wonder gold keeps rising in price. Investors just don't believe qualified finance professionals anymore, so they'd rather trust a shiny metal with easily recognizable value.

Full disclosure: No positions in banks or Eurozone debt at this time. Long GDX with covered calls.

Monday, March 12, 2012

Molycorp has been consistently ahead of the game in rare earth metal production. They were first to see the potential in reactivation of the old Mountain Pass rare earth motherlode. Now they're the first REE producer to move toward large-scale vertical integration. Molycorp's $1.3B offer for Neo Material Technologies will give the combined company end-to-end control of an entire REE value chain, from ore to finished products (specifically magnets).

Molycorp made a bold move last year with a $35M investment in Boulder Wind Power. This investment sustains a wind turbine technology that is not dependent on dysprosium and is strategically complementary for Molycorp given that company's seeming lack of dysprosium among its deposits. I've seen other media reports that describe Boulder Wind's technology as "non-ferrous," which is curious given Molycorp's move toward neodymium-iron-boron (NdFeB) magnet combinations.

It's worth noting that Great Western Minerals Group has had a well-integrated business model for many years. Molycorp's model is large in scale and is notable for having something that has eluded Great Western for some time: profitability.

Saturday, March 10, 2012

A default is a default, no matter whether the debtor calls it a partial exchange or something else. The ISDA finally admits as much in the Greek situation. It didn't have much of a choice. If the ISDA had ignored the effect of the debt swap on existing creditors, it would have called into question its reason for being. I've always believed that credit default swaps are meaningless and even dangerous. Banks and hedge funds use them to place directional bets with no regard for a counterparty's solvency. The European versions of AIG, whoever they are, can now breathe easier for a few weeks knowing they can get away with more uncapitalized CDS writing.

The ISDA's decision prevents an immediate seizure of the credit markets that would have made 2008 look tame. The equity markets are closed and have the weekend to mull over this decision. I contended in one of my recent blog posts that Europe's approach to resolving Greece's debt would result in slow-rolling trouble for a select number of hedge funds and banks. Dragging things out this way prevents a cascade of simultaneous defaults provided Greece remains the only trouble spot. The rest of the PIIGS still get a vote, and when they eventually step up to bat the world's central bankers won't be able to raise enough capital to save them all. The final option central banks can employ would thus be hyperinflation.

So far, so good. The few hundred central bankers, finance ministers, and their staffs running this show have done a masterful job slowing down this collapse. It remains a collapse, because the Greek state pension funds that were forced to take cramdowns won't be able to meet their payouts for years even if government employees agree to further cuts. That will make for a fun electoral season in Greece, with political beliefs previously thought long gone preparing for resurrection. Remember Communism? How about extreme nationalism? Turn back the clock to the future.

I actually once considered opening a futures account with Refco, MF Global's predecessor firm, years before it collapsed. I decided against it mainly because I'm not some heavy commodity user who really needs a hedge. There are plenty of ETFs in oil, metals, and agriculture to satisfy the diversification needs of most normal investors.

Trust is in short supply. Even big companies can't trust their brokerages anymore. I hope these Fortune 500 victims get together and strategize some lawfare that will bury the MF Global malefactors in a big pile of . . . well, you can insert a fanciful agricultural commodity here.

Wednesday, March 07, 2012

Here it comes. It's a moment many gadget addicts have anticipated. Apple is rolling out a 4G iPad. That's nice for those folks who like throwing away $499 on something that is only a marginal improvement over the previous thing that now costs "only" $399. This does not count the monthly subscription you pay to a WiFi service, which by definition is unsecure and easily sniffed by hackers. I just don't get how people can get excited over something that has to be completely replaced when the battery goes out.

I'm sounding a wake-up call that will go unheard but I can't live with myself by remaining silent. The genius factory that Steve Jobs built is just another oligopoly pushing planned obsolescence on a buying public that should know better. The cute little tablet that took the world by storm is just a commodity to this here non-user. Pretty soon all of the Chinese engineers reverse engineering the thing will have a generic copy out for less than $50. Electronic book reading is the future but that does not mean the future has to be expensive. There's only so much market growth a premium electronic product can wring out of the industrialized West and Apple's marketers know it. They don't waste time growing the nonexistent iPad market among African bushmen who live beyond the reach of a WiFi signal. Instead, they know the real money is made from selling tiny improvements to existing customers who just have to show off the latest gizmo to friends. That's the real genius of the iPad's adoption. It's not the capabilities that matter; it's the peer acceptance.

Having common sense does not make me a Luddite. My first computer was an Apple Macintosh because I had grown accustomed to using one in my undergraduate studies. My next one was a PC because I needed something that was cheaper than a premium product and would translate to what the rest of the world used. Apple's technology is great for getting hobbyists excited. My rose-colored glasses came off years ago.

My mailbox is getting full again. Sometimes it's full of invitations to cultural events in San Francisco or local business conferences. Sometimes it's full of informative periodicals that keep me up to date on my favorite sectors and technologies. Sometimes it's even full of baloney. I got a free mailer recently from none other than my favorite whipping post, Trinity Investment Research. Take a gander back at many of my postings for the past few months and you'll see my reflections on the stocks they've touted. I just couldn't wait to digest their latest missive.

This latest mailer was pumping LTS Nutraceuticals (LTSN). I'm wondering just what a "nutraceutical" is supposed to do. It sounds like something you eat that might cure an ailment. Man, it sure would be great to bite into a granola bar that cures cancer. Maybe this company makes some kind of "superfood" like an acai/pomegranate smoothie. I'm getting hungry already.

Trinity's brochure didn't describe this company's products very well. I had to dig through LTSN's website to discover that it sells vitamins and dietary supplements though network marketing. The website also touts the "entrepreneurial opportunity" of selling this stuff. That almost sounds like Herbalife, which already has a pretty good lock on this kind of distribution channel. You can probably find some former Herbalife distributors in line at your local unemployment office. Ask them just how much success they had with creating personal distribution channels that compete directly with retail grocery stores and pharmacies.

Enough with the conjecture and comparison. Look at LTSN's facts. They've been around since 2010 with net losses, negative retained earnings, and negative free cash flow. Yeah, this one meets all of Trinity Investment Research's criteria alright but in fairness they haven't been around long enough to lose as much money as some of Trinity's other picks. The company's Form 8-K disclosures in the past few months discuss some acquisitions of product lines, but frankly the terms of those acquisitions look to be very disadvantageous to LTSN shareholders. There is also little to differentiate the company's products (like some calcium-enriching supplement) from mundane solutions (like good old-fashioned Pasteurized milk).

This is one investment I just can't stomach. Thanks again, Trinity Investment Research, for giving me some amusement. Your so-called "breakaway stocks" make me want to break out an indigestion remedy. Hey, maybe that's something LTSN could distribute just for Trinity's newsletter subscribers.

Consider how American policyholders would feel if insurance companies decided that this week's losses from storms and tornadoes did not constitute loss events. The insurance companies, in a nation subject to the rule of law, would face class action lawsuits from aggrieved homeowners who would win big settlements. In neofeudalism, the insurance companies would survive because the losses are limited to a small number of policyholders in politically unimportant areas. The insurers would also be able to send goons to threaten any policyholders who complain.

The ISDA's decision is not far removed from something a king would do to a feudal subject just for sport. Expect more lawlessness from financiers who pay to write laws.

Banks know as well as anyone - well, probably better than the average person - that the Fed's dollar debasement policy will eventually push serious inflation into the economy. Inflation destroys the value of fixed income instruments. Banks have every reason to be concerned about how badly inflation will hurt the book value of loans they've issued. Holding hard assets on their balance sheets can ameliorate the effect of inflation on their loan portfolios. How much it will help will of course vary by institution, but those TBTFs that went hog-wild with home mortgages have the most to lose from inflation. They know who they are. BofA's rush to buy Merrill Lynch may be a saving grace if the bank can hold onto whatever hard asset store Mother Merrill is allowed to retain..

The Fed may not have much choice but to accommodate banks' desires to continue holding commodities, even if they are restricted in trading them. Think of a hard asset hoard as a balance sheet backstop that gives the Fed time to delay further QE. Keeping this grandfather exemption for bank holding companies will give the Fed room to focus liquidity backstops on banks that didn't do much trading with commodities. Helicopter Ben needs to think about how he can make the Fed's job less difficult as we approach the next round of the financial crisis. Think hard, Ben. Think hard assets.

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Alfidi Capital is a private financial research firm.Alfidi Capital is not affiliated with any broker-dealer and does not manage money for clients.All information mentioned in this blog is derived from public sources.Alfidi Capital makes no representation as to the accuracy or completeness of this information.Alfidi Capital and its owner, Anthony J. Alfidi, may from time to time hold long or short positions (including options, warrants, rights, and other derivatives) in the securities mentioned in this blog.This blog is provided for informational, educational, and entertainment purposes only and does not constitute a recommendation or solicitation to execute a transaction in any investment product.Investors should consult with a properly licensed and registered investment professional before making any investment decision.The bottom line:Enjoy reading this blog, but the risk you take with investing is entirely your own.